Getting Paid to Collect Yield

Despite the political turmoil of the past few months, which sometimes made it seem that the post–Word War II order of the world is at risk, the
S&P 500
index and the
Cboe Volatility Index,
or VIX, remain at reasonable levels—and stocks are on pace to finish the week up 2%. But it’s hard to dismiss the growing number of respected investors who are expressing caution about the long-running bull market.

Sam Zell, the billionaire real estate tycoon, told CNBC on Wednesday that he has more cash than ever before. Warren Buffett, who seems to enjoy buying amid chaos and fear as much as he likes value investing, is holding a record $122 billion in cash at Berkshire Hathaway.

Ray Dalio runs Bridgewater Associates, the world’s largest hedge fund. He recently wrote that the current market reminds him of the 1930s, citing central banks’ limited ability to stimulate their nations’ economies, large wealth and political polarity, and the conflict between rising world power China and existing world power America. “If/when there is an economic downturn, that will produce serious problems in ways that are analogous to the ways that the confluence of those three influences produced serious problems in the late 1930s,” he argues.

The world’s two largest economies, the U.S. and China, are locked in an escalating trade war that is arguably as much about global domination as economics. The United Kingdom is trying to leave the European Union. Economic data in the U.S. and abroad is increasingly downbeat.

In moments like this, the options market offers a window into the minds of sophisticated investors. Here, largely out of sight, they use puts and calls to express their directional views. Increasingly, signals suggest preparations for a market decline.

On Tuesday, for example, Susquehanna Financial Group’s Chris Jacobson reported big bearish trades in puts on the SPDR S&P 500 exchange-traded fund (ticker: SPY). Investors bought 25,000 September $261 puts that expire on Friday, 70,000 September $265 puts that expire on Sept. 9, and 50,000 September $250 puts that expire on Sept. 11. Large positions in extremely short-dated options are unusual and indicate high convictions about a decline.

This column has recommended buying gold and exchange stocks, selling stock and replacing the positions with upside calls, and hedging portfolios. Recently, we have often cited one of our favorite strategies: selling puts on blue-chip stocks that pay dividends to enhance returns on idle cash.

The options market is always willing to pay investors for agreeing to buy stock, and if the shares never decline below the put strike price, investors can earn a few percentage points on their cash, just for selling the put.

Consider
Southern Co.
’s (SO) February $60 puts. When the stock was around $60, they could be sold for $2.92. If the stock is above the put strike at expiration—and utility stocks with high-dividend yields are in demand—investors can keep the premium, which represents a 5.1% return on cash.

Should the stock be below $60 at expiration, investors get paid to buy a stock with a 4.14% dividend yield. During the past 52 weeks, it has ranged from $42.50 to $60.15.

The key risk is that the stock could fall far below the strike price, but that seems unlikely in a world increasingly defined by negative interest rates, which have made investors hungry for yield.

Getting Paid to Collect Yield

Despite the political turmoil of the past few months, which sometimes made it seem that the post–Word War II order of the world is at risk, the S&amp;P 500 index and the Cboe Volatility Index, or VIX, remain at reasonable levels—and stocks are on pace to finish the week up 2%.

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